Jonathan Watts-Lay, Founder and Director of WEALTH at work

The journey to retirement, once a relatively straightforward path, has become increasingly complex, particularly since the advent of pension freedoms in 2015. While these freedoms offer unprecedented flexibility, they also introduce challenges, especially concerning how individuals manage their accumulated savings at the point of retirement. The Pension Schemes Bill, currently making its way through the legislative process, seeks to address some of these complexities, particularly in how pension schemes treat defaults at retirement.

The Pension Schemes Bill and Defaults at Retirement

A key focus of the Pension Schemes Bill is to enhance consumer protection and ensure better outcomes for pension savers. While the precise mechanisms are still being refined, the Bill aims to ensure that pension savers have a default option at retirement if they fail to make a proactive choice.

The Bill is attempting to introduce measures to provide a default decumulation pathway. This is intended to be a framework where schemes must offer a well-designed, pre-selected option for members who do not actively choose how to access their pension. The intent is to prevent members from falling into a "do nothing" trap or making ill-informed decisions due to a lack of engagement or understanding. However, there is a real danger that taking an automated default pathway will result in the industry revisiting the problems associated with annuities pre-Freedom and Choice, where customers regularly defaulted into the Annuity of their pension provider whereas they could have got a much better deal elsewhere.

The Problems Associated with Pension Defaults Not Serving Customers' Best Interests

The problems stemming from retirement pension defaults not serving customers' best interests are significant. Firstly, a one-size-fits-all default, particularly in the post-freedom era, is inherently problematic. Retirement needs are highly individual: some may have significant other assets, others may rely solely on their pension; some may have health conditions affecting life expectancy, others may be in excellent health; some may desire a guaranteed income, others prefer flexibility. A generic default solution cannot possibly cater to this spectrum of needs, potentially leading to:

• Suboptimal income: An individual defaulted into drawdown may end up with higher charges and therefore less income than might be achievable elsewhere – in other words less income every month of retirement. Alternatively, they may default into an annuity option paying less than they could achieve elsewhere.
• Tax inefficiency: Without tailored financial advice, a default option might not be structured in the most tax-efficient way, leading to unnecessary tax and again a reduction in income.
• Lack of flexibility: Even if the default is appropriate at the point of retirement, needs will change over what maybe 25-30 years in retirement, so how will the default ‘flex’?
• Multiple pots: Many will arrive at retirement with multiple pension pots with differing amounts in each – how will defaults work when each pension provider is only aware of the pension with them? The individual could end up with a myriad of defaults based on different pot sizes – what could be called the ‘spaghetti’ option!

These issues highlight a fundamental disconnect between the broad design of a default and the specific, nuanced requirements of an individual's retirement plan.

It should also not be forgotten that pension providers have a big commercial incentive to keep hold of an individual’s pension pots at retirement, so defaults will help them to keep the assets, and therefore the fees, whether it is in the customers best interest or not.

The Importance of Getting Guidance and/or Regulated Financial Advice Regarding Your Pension at the Time of Retirement

Given the complexities and potential pitfalls outlined above, the importance of obtaining guidance and/or regulated financial advice in the lead up to retirement cannot be overstated. After all, for many it will be the biggest financial decision of their lives. Truly understanding available options and the advantages and disadvantages of each is important if an informed choice is to be made.

By definition, defaults will be designed for the average person, when retirement is a unique phase of life requiring a tailored financial strategy based on 40 years+ of savings. Financial guidance and/or advice at this critical juncture is not an expense, but an investment in securing a comfortable, flexible, and financially sound retirement. In fact, many large employers now offer guidance at no cost to those approaching retirement so the cost for the individual is zero, the only investment is time!